A Comparative Review of Islamic Versus Conventional Microfinance In Bangladesh

Transcription

1 8 th International Conference on Islamic Economics and Finance A Comparative Review of Islamic Versus Conventional Microfinance In Bangladesh Dewan A. H. Alamgir 1 M. Kabir Hassan 2 Hisham Haider Dewan 3 1. Introduction Background This paper presents a comparative review of Rural Development Scheme (RDS), i.e. microfinance operations, of Islami Bank Bangladesh Limited (IBBL) and financial services offered by traditional microfinance institutions (MFIs) in Bangladesh. The review was undertaken in July-August The major topics discussed in this paper are: evolution and structure of microfinance sector in Bangladesh including regulatory regime, management system of microfinance institutions and RDS, outreach of microfinance services, market segments and products of MFIs and RDS, financing of microfinance institutions, comparison of financial performance of some major MFIs and RDS, and impacts of microfinance on poverty. Bangladesh is one of the poorest countries in the world in terms of income and other social and economic indicators. In 1990, approximately 58.5% of the population lived below the poverty line, which gradually improved to 40% in About 18% of population lives in absolute poverty who suffer from food insecurity coupled with illiteracy, lack of proper health and sanitation facilities. The country's economy depends on agriculture with vast majority of the population living in rural areas but industrial sector, especially garments manufacturing, and service sector have significantly expanded. The agriculture sector is unable to create new opportunities for employment resulting in influx of rural population towards urban areas. Rural areas are characterized by almost stagnant agriculture and scanty industries. Underemployment and unemployment is a regular phenomenon particularly in rural areas. The vast human resources have remained unutilized due to lack of education, proper training and concerted efforts to help grow the rural economy. But even with all structural odds, political instability, natural disasters and worldwide recession Bangladesh has maintained around 5% annual GDP growth over the last two decades and steadily reduced poverty except in 2007 and 2008 when sudden increase in prices have made poor people suffer. In 2010, the GDP per capita has exceeded USD 750. A number of factors contributed to these results: international remittance, labor intensive garments industry, some diversification within the agricultural sector, economic reforms, various poverty alleviations programs and microfinance. Microfinance institutions played a major role in the poverty alleviation, making access to savings and credit easily available at reasonable cost to more than 30 million poor and near-poor people. Besides non-government organizations (NGOs) contributed in spreading literacy and primary healthcare services. 1 Independent Consultant, Bangladesh 2 Corresponding Author, M. Kabir Hassan, Department of Economics and Finance, University of New Orleans, New Orleans, LA 70148, USA, Office: , mhassan@uno.edu. 3 University of Dhaka, Bangladesh 1

2 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation The microfinance sector, which is the focus of this paper, has undergone tremendous transformation in all aspects over the last more than three decades following pioneering works of the Grameen Bank. Following the success of Grameen Bank, many MFIs have proliferated throughout Bangladesh. The very visible changes are increases in outreach and portfolio size, proliferation of microfinance through a large number of microfinance institutions, diversification of services, new regulatory regime, contribution in rural development, and recognition of microfinance as a major contributor in poverty reduction. The methodology of Bangladeshi microfinance model has been replicated with or without variations in many countries and recognized as an effective tool for poverty reduction. That has also brought international recognition in the form of Nobel Prize for Peace for Professor Mohammed Yunus and the Grameen Bank. IBBL, a leading private Islamic commercial bank, was founded with the major objective of establishing Islamic economy for balanced economic growth by ensuring reduction of ruralurban disparity and equitable distribution of income. Branches of the Bank have been encouraged to invest their deposits in their respective areas and in particular for the economic uplift of the rural people. In addition to its commercial banking operations, IBBL introduced its own version of microfinance called 'Rural Development Scheme (RDS)' in 1995 by practicing Islamic modes of finance to cater to the investment needs of agriculture sector and rural poor to generate employment opportunities, enhance income to alleviate poverty. As we will explain in details in this paper that RDS, a division of IBBL, is offering an Islamic alternative to microfinance services offered by traditional MFIs in rural Bangladesh. Objective The overall objective of the review is to offer a comprehensive analysis of RDS, and compare and contrast between RDS and microfinance services offered by MFIs, and performance of microfinance institutions of Bangladesh. In particular, we will compare financial performance of RDS with a reputed MFI, BURO Bangladesh, which is of similar size to RDS. The comparison covers outreach, products and market segments, management system, financing and financial performance. The review also covers evolution of microfinance and regulatory environment in Bangladesh. Methodology The review is primarily based on secondary and published information. The paper heavily draws on Bangladesh Microfinance Country Report prepared for the Institute of Microfinance (Alamgir 2009) for information and analysis on Bangladesh microfinance sector. The major sources of information are published research reports and papers, unpublished reports from reputable organizations, data from major institutions such as Palli Karma-Sahayak Foundation (PKSF), IBBL-RDS, Institute of Microfinance, Microcredit Regulatory Authority (MRA), Grameen Bank, BRAC, ASA, BURO Bangladesh, Credit and Development Forum (CDF) etc. We have also conducted a limited number of interviews. The case of microfinance in Bangladesh is a good example of NGO-MFI led operations where the government directly and indirectly provided major policy and material support to make it probably the largest microfinance sector in the world. State-owned commercial banks although initially tried retail microfinance services but abandoned that after failure with the exception of RDS-IBBL. Readers should look into the paper with this perspective in mind the key differences and similarities between traditional microfinance and RDS-IBBL. 2

3 8 th International Conference on Islamic Economics and Finance 2. Bangladesh Microfinance Sector: Evolution and Current Structure Definition and targeting Bangladesh microfinance has earned world attention due to the pioneering role, enormous size, presence of famous institutions, and replication of its model or variants worldwide. The expansion and replication is going on and attracting many different types of people and institutions. The term microfinance is relatively new in Bangladesh. A more popular and practical term has been microcredit, which emphasizes the main focus of the various financial institutions involved, although small savings has always been a part of microcredit operations. Gradually, in response to demand, other services such as savings, insurance (life and non-life) and remittance services have been developed or being piloted and are now being bundled together under the term microfinance. Another important feature has been the focus on the poor. That focus very much remains but the MFIs have started to offer services to non-poor such as small farmers and micro-entrepreneurs. Therefore, the scope and target beneficiaries have evolved over time since the establishment of the Grameen Bank in In 2010 the term microfinance includes many financial products for both the poor and the near-poor. The microcredit programs in Bangladesh rightly began by targeting the rural poor, especially women, as a development intervention strategy. Microcredit serves not only to meet financial needs but also contributes to other social and institutional development issues such as women s empowerment, bringing the rural poor into an institutional service network, and reducing the dependency on informal money lenders. The management system of microfinance programs has evolved over time but commonly have the following features: Women are the main recipients of microfinance services though many MFIs now have male members/clients; Group-based lending methodology is the main system of delivery of microfinance services, although commercial banks and a number of MFIs offer loans to individual clients. In early 1980s, especially in Grameen Bank, groups not only meant a collection of members for administrative purposes but also meant group liability. In case of loan default by a member, the group would take responsibility for the repayment of the defaulted loan. Now in 2010, the group-based system provides just a low-cost management structure, without any responsibility of repayment; that is the responsibility of the individual borrower. However, groups do serve another practical purpose, as a filter for screening individuals for membership; The microfinance sector in Bangladesh is now dominated by NGOs offering microfinance services, collectively known as NGO-MFIs, which offer financial services as private notfor-profit businesses but strive to achieve institutional and financial viability as soon as possible; MFIs are diversifying into other target segments, including near-poor groups, by developing new financial products along with the traditional management system. This diversification strategy is not only helping portfolio growth and outreach but also transforming NGO-MFIs as permanent financial service providers for both the poor and the near-poor, amongst both the rural and urban populations. NGO-MFIs have now become a new class of financial institution in Bangladesh financial markets. 3

4 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation Target Groups: Aggressive expansion of microfinance in rural and urban areas by competing MFIs, i.e. Grameen Bank and the NGO-MFIs, has created a situation warranting a revised definition of target beneficiaries of microfinance programs. On paper the definition still remains poor people having less than half an acre of land or some other income and employment criteria. In reality, women from so called non-target groups, mainly from marginal farmer category, are joining in large numbers. The attitude about microcredit has changed over the time. Over the last two decades, the Grameen Bank together with many NGO-MFIs now operating in Bangladesh have become permanent features of rural financial life and formal/institutional sources of loan with costs far lower than moneylenders rates. At the same time due to their contributions and national and international admiration, MFIs have achieved social recognition as well. That means, two compelling forces the urge to expand services to maintain portfolio growth and the demand from former non-target groups - have been contributing to the expansion of services as well as the need to redefine the target group for microcredit. A new definition of target recipient is now beginning to emerge: anyone in rural or urban areas who wants to take a small loan by accepting the institutional arrangements of the MFIs, i.e. group meetings, mandatory savings deposits and repayment schedule. Irrespective of actual economic conditions, such an individual is now a target recipient and includes nearly 90% of rural households. It only excludes the larger farmers and other richer families. It does not mean that microfinance now excludes the poor; far from it since the ongoing expansion thrust already includes most, if not all, of the potential moderately and hard core poor borrowers under one or more of the existing programs. The inclusion of former non-target groups means simply broadening the outreach. In addition, there are two deterrents for richer borrowers joining mainstream microfinance: i) small size of loan; and ii) higher interest rate of microcredit (25-30%), which is almost two-three times the rate of commercial banks ( %), the normal sources of loans for richer borrowers. Table 1 provides a classification of poverty groups and corresponding strategy followed by the microfinance sector to serve each group with financial and non-financial services. Each of these groups is then discussed further below. 4

5 Target Beneficiary Segments Hardcore poor (Extremely poor or ultra-poor) 8 th International Conference on Islamic Economics and Finance Table 1: Common Microfinance Client Segments and Characteristics Characteristics of Each Segment Daily calorie intake: less than Land ownership: less than 0.15 acre Food deficit status: Occasional to chronic deficit Moderately Poor Daily calorie intake: less than Land ownership: less than 0.5 acre Food deficit status: 30-40% above poverty line Marginal farmers Land ownership: less than 1.5 acre Small Farmers Microentrepreneurs Food deficit status: break-even Landownership: less than 2.5 acre Food deficit: Surplus Normally no-poor Managed by owner; less than 10 employees Partly linked with mainstream market May possess capital machineries Investment normally higher than income generating activities; Need larger loans Service Needs of the Beneficiaries (financial and non-financial services) Primarily savings services; Starts with food aid; skill training; and very small loans Savings and credit services; Flexibility in services desirable; Selective productive skill training Agricultural extension services; Selective training on non-crop income generating activities; Savings and credit services. Agricultural extension services; Training on diversification in farming and other areas and new farming technologies; Savings and credit (larger and seasonal loans); Access to market and farm inputs. Credit services (substantially larger: USD ) Business development services including access to market and product development. Sources: As presented in Alamgir 2009; MIDAS and ICG (2004); Wright and Alamgir (2004); McKennie and Rahman (2003) Common Strategy Followed in Bangladesh Skill training Savings services Small amount of loan Food aid and asset transfer Savings and credit services Limited number of NGOs is in this market segments; some marginal farming families included in regular microfinance groups. Savings and credit service A few NGOs are involved; mainstream NGOs are yet to get involved in this market segment; limited savings and credit services. Credit service similar to regular microcredit with larger loan size. 5

6 Evolution of Microfinance Commercial banks, agricultural banks, cooperative societies were the principal sources of small loans for various types of clients: farmers, traders and cottage industries before the advent of the Grameen Bank and other MFIs. These institutions continue to provide some small loans to selected clients but not normally to the poor. The limitations of commercial bank loans were well-known: banks ask collateral for disbursing loans, their human resources and management systems are not suited to the poor and their branch networks were limited to urban centers. Although state-owned expanded branch networks in rural areas, other limitations persist. Bangladeshi private banks have never been interested in small loans or poor people and the culture remains the same even today with the exception of Islami Bank Bangladesh Limited which has a large retail microcredit operations. Some private commercial banks have lately gone into wholesale lending to the MFIs. Two agricultural banks, BKB and RAKUB, mainly targeted and still target the small, medium and large farmers who could offer land as mortgage. The performance of these two specialized banks has always been poor and largely avoid the poor and both are deeply insolvent [Ferrari 2008]. Cooperative societies tried to reach the small and marginal farmers in 1960s and 1970s as a follow-up on to the success of the Comilla model. Several distinctive features of Comilla model were as follows: targeting the farmers, especially the small farmers; introduction of technologies (HYV seed, chemical fertilizers, irrigation and new farm practices); loan was given to the farmers against land mortgage. The relevant issue here is that the cooperative system also could not organize the poor for delivering financial services. Bangladesh Rural Development Board (BRDB) later introduced many microcredit projects funded by bilateral and multi-later donors with some initial successes but on the whole the programs should be termed as unsustainable (Khandkar and Khalily 1996). Grameen Bank made the breakthrough to develop a management system to reach large number of poor with financial service. The Grameen Bank broke the barriers by developing a different kind of organization for the poor and to serve the poor with financial services. The story of Grameen is pretty known now in Bangladesh and elsewhere. The Bank started as project in 1976 and become a formal independent financial institute in 1983 under the Grameen Bank Ordinance Detail story of background and formation of Grameen Bank is available in Counts (1996). The features of microcredit mentioned earlier are basically developed by the Grameen Bank and later modified (mostly minor) by other MFIs to suit their purposes. The Grameen experience had proven that with right kind of savings and loan products, policies and management system and human resources, i.e., an appropriate institution with a mission to serve the poor could not only reach them but also make a viable financial institution. The simplicity of methodology developed by the Grameen Bank has inspired many non-governmental organizations to hurriedly replicate the model and offer similar financial services to the poor. The main incentives for NGOs which were normally involved in many social programs such as education, health, relief and rehabilitation to move quickly into microcredit were demand from the members, opportunity to become self-reliant (income covers expenses), and creating sustainable 6

7 8 th International Conference on Islamic Economics and Finance permanent institution, and career for staff members. The variations were in interest rate, savings and loan ceiling, size of groups etc not much on the fundamental structure of the model. Some of variations present today are summarized below: Group formation: The size may vary between 20 to 50 persons. MFIs do not strictly follow 5-member group structure of Grameen, instead they form one larger group called samity with women/men from the same neighborhood. Savings policies: Amount of savings may vary among members as well as organizations. Normally MFIs would lend only after deposit of several weeks or certain amount of money. Withdrawal of savings was restricted in earlier days now lot more accessible. Still a few major institutions restrict withdrawal of savings to use the money as loan as well as cash collateral. Interest paid on savings may vary between 4 to 8.5% (Grameen Bank). Loan policies: Loan amount widely vary among MFIs; normally starts with small size and increase in successive loans. Interest rates vary between 20 to 30% per annum expressed in so called flat rate. Loans are collected in weekly installments but in some cases in monthly and one installment. Although in earlier days clients were required to wait 1 to 6 months before receiving first loan but now a days due to competitive pressure first loan to a member may be disbursed within days of joining a group. Prevailing Lending Modalities Three different types of lending technologies are applied in Bangladesh: Grameen styled group-based system is the dominant management system with features mentioned earlier. But critics feel that the weekly repetitive system does not match with poor people s financial demand, therefore, the financial products should be flexible or demand driven. Self-help group system: A handful of non-government organizations have tried and are still trying the so called self-help group approach of developing financial service delivery system. In this case, the promoter or the NGO organizes self-help groups with the objective of facilitating savings mobilization for the poor women/men from among themselves. If the participating members need loan they can borrow from their samity i.e. from their own savings funds. If the funds are not adequate, the self-help samities may try to borrow from banks or the NGO supplies the additional capital. Individual lending system: The central issue to developing individual system as opposed to group-based system is to offer flexible and demand-driven services to each client/borrower. Group-based system is viewed as one-size fits all system. The individual lending technique, i.e. to offer savings and credit service to each individual according to the demand of that individual client. In case of microenterprise loans (i.e. larger loans) are offered by MFIs as individual loans. Informal moneylenders are another traditional source of micro-loans that follows individual lending. No rigorous up to date information and analysis are available 7

8 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation about their operations. Even with the expansion of MFIs moneylenders can still be found lending for emergency loans to the poor and also for agricultural loans due to the absence of large-scale agricultural loan from MFIs. Microcredit products and market segments (a) Mainstream Microcredit (BDT 5,000-25,000, approx USD ): The term mainstream microcredit is the most commonly available financial service for the moderately poor following the Grameen model of group-based lending. This category includes the common programs of NGO-MFIs serving the poor and moderately poor, which sometimes may include some not-so-poor members, especially marginal farming families. The current loan size varies between BDT 5,000 to BDT 25,000, which is normally invested in petty trades, poultry and livestock, fisheries, numerous small agroprocessing activities and horticulture. Loans are for one year collected in weekly installments. The interest rate varies between 20-30% per annum. The main focus remains on poor women. (b) Programs for the Hardcore Poor (BDT 500-5,000, approx USD 7-70): Two approaches have been adopted to redress the problem of meeting the needs of the poorest for financial services. The first is that the very poor need to be prepared for microfinance, usually by a combination of social and human development interventions. The second is that microfinance needs to be prepared for the very poor, i.e. that what is required is much greater flexibility and imagination in both the products offered, especially for savings, and in the manner in which they are offered. Improvements and innovations will be needed not only for serving various financial needs of the very poor but also to face competition. Examples of such programs are Building Resources Across Communities (BRAC) s 4 Challenging the Frontiers of Poverty Reduction (CFPR) Programme; Grameen Bank s Struggling Members Programme, and PKSF s Hardcore Poor Programme. A number of programs even provide training, cash for work and productive assets to these groups. (c)microenterprise Program (BDT 25, ,000; approx USD 350-7,000): One relatively new frontier for the MFIs is loans for the development of microenterprises managed by graduates from microfinance programs as well as millions of informal businesses operating throughout the country, which so far have been outside the MFIs traditional lending programs. This segment is significantly underserved, but potentially involves very large number of enterprises (more than 5 million) and opportunities for 5 employment, including wage employment. NGO-MFIs use both group-based (e.g. PKSF small and medium partner MFIs) as well as individual (e.g. ASA and BRAC) lending methodologies in case of microenterprise loans depending on whether they finance graduate borrowers (e.g. PKSF partner MFIs) or new entrepreneurs (e.g. ASA and BRAC). In case of ASA and BRAC, most of the microentrepreneurs are men.two features separate them from microcredit borrowers: larger loan amounts with longer 4 Formerly Bangladesh Rural Advancement Committee (BRAC). BRAC has opened its operations in Sri Lanka, Afghanistan, and several countries in Africa. 5 MIDAS and ICG (2004). National Enterprise Survey, MIDAS, Dhaka, Bangladesh 8

9 8 th International Conference on Islamic Economics and Finance duration; and the need for non-financial services such as access to market, information and appropriate technology, assistance for product improvement and development, training for workers skill development and management training for skill in financial and business management of the entrepreneurs. (d) Microfinance for Marginal and Small Farmers (BDT 10,000-50,000; approx USD ): So far only a small number of MFIs has ventured into this segment by following group-based lending techniques with limited outreach. PKSF with loan from IFAD has initiated Microfinance for Marginal and Small Farmers (MFSMF) project to reach 220,000 marginal and small farmers in 6 years. Sometimes seasonal loans with shorter duration (3-9 months) are disbursed and collected in one installment, for example after harvest. For this category, MFIs follow group-based lending system and cater mostly to women groups. But a number of MFIs have been lending to men s groups only with impressive success. Microfinance Sector Structure An estimated 33 million members and million borrowers (81.1%) including multiple memberships or so called overlapping are served by the sector at the end of December A total of 14,441 branches serve these members/clients. The total estimated portfolio is Taka 158,807 million of which ASA (22.50%), BRAC (28.81%) and Grameen Bank (27.96%) account for about 79.26%. The rest 20.74% is under about 700 smaller MFIs that shows heavy concentration of portfolio in these three organizations. The important issue is that the three MFIs have become so big that microfinance sector can not afford any one of them to fail. Due to resource and management constraints the smaller MFIs are not expected to grow fast to increase market share. Such skewed structure is expected to continue. Table 2: Aggregate time series data (Grameen Bank included) Description Branches (#) 6,837 9,165 9,253 11,368 14,577 14,441 Members (#) 17,754,747 20,681,349 24,373,389 27,420,570 31,367,009 33,018,926 Borrowers (#) 13,457,991 15,617,075 15,617,075 15,617,075 26,119,391 26,787,120 Portfolio (Taka mill.) 52,510 64,354 83, , , ,807 Source: Alamgir, 2009 In terms of memberships/clients (and consequently portfolio size) the structure of the microfinance sector is as follows: Three very large MFIs: Three very large organizations ASA, BRAC and Grameen Bank- dominate the microfinance sector, each having more than 7 million members/clients in 2008 (ASA 7.28 million, BRAC 8.15 in March 2009 and Grameen Bank 7.67 million) all products combined (see Table 3). These three organizations had embarked a major lateral expansion beginning 2003/04 that led to doubling to tripling their sizes by These three MFIs have achieved spectacular lateral expansion, that is, to include new clients in same or new geographical areas by enhanced management efficiency, standardized management practices, products and 9

10 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation policies, and mobilizing financial resources. The three combined has 8,547 branches, million borrowers and loan outstanding of Taka 125,876 million at the end of December 2008 (ASA Taka 35,735 million, BRAC Taka 45,746 million in March 2009 and Grameen Taka 44, million). All three organizations have branch networks throughout the country except in a few remote char and coastal areas. Large MFIs: The sector has got a group of large MFIs whose memberships vary between 50,000 to one million. All of them are PKSF partner MFIs except BURO Bangladesh. Even within the group two organizations, TMSS and BURO-B separate them from the others and have expanded more than into 40 districts with their networks. Their expansion also came during period and continues. Medium Size MFIs: Above two groups are followed by organizations with 5-50,000 members (3 to 30 branches) which are local or regional organizations mostly financed by PKSF. Small MFIs: MRA has a cut-off point of 1000 membership and Taka 4 million loan outstanding for receiving license. Several hundred such MFIs operate in the country although the exact number is not known. Very small MFIs: We see even smaller NGOs with very limited resources for loan disbursement, use mostly savings, are still operating which may face extinction for not qualifying for license. Indicators Table 3: Structure of MFIs Sector ASA (Dec. 2008) BRAC (Mach 2009) Grameen (Dec. 2008) Total Member (Million) Borrower (Million) Loan outstanding (million Taka) 35,735 45,745 44, ,876 Savings balance (million Taka) 11,264 16,306 64,177 91,747 Branches 3,303 2,705 2,539 8,547 Source: Compiled by authors Regulatory environment Multiplicity of registering authority: The microfinance institutions of Bangladesh are registered under the following laws: 1. Social Welfare Act The Companies Act 1913 (revised in 2001) as non-profit company 3. The Trust Law 4. The Societies Act The Cooperative Societies Act 10

11 8 th International Conference on Islamic Economics and Finance Interestingly none of these laws explicitly allows microfinance, especially the mobilization of savings, as all were drafted long before the advent of the present form of microfinance. All the laws do, however, allow development activities, development of the poor, development of women and society, promotion of education, science and technology etc. NGOs did not start microcredit as their first activity but followed Grameen Bank s success. Microfinance programs have been implemented as a development activity in order to alleviate poverty. Critically, GOB, Bangladesh Bank and all the registering authorities responsible for the different laws cited above chose to ignore savings mobilization as a part of offering microcredit to the poor, though it was technically illegal. Bangladesh did not have any comprehensive law, or body of regulations or regulator for microfinance up to August Microcredit Act: The Microcredit Act 2006 filled this gap with the following features: a) MFIs legally created under any of the previous laws will receive licenses to offer microcredit subject to fulfilling criteria set by MRA; b) The law created an independent regulator called Microcredit Regulatory Authority (MRA), with Governor of Bangladesh Bank as its Chairman, to issue licenses and supervise all MFIs; c) The MRA has wide ranging powers to introduce regulations, set interest rates, revoke licenses, set standards etc.; d) The microcredit programs of various government departments are not under the supervision of MRA. In accordance with the new law, the MRA has now been set up. All members of the governing body are government officials except the managing director of PKSF, a private individual. The MRA has already started its functions and issued about 500 licenses. Although MRA has been issuing licenses but the body of regulation has not been introduced yet. MRA on its parts has developed a set of regulations but could not introduce them of its own without the approval of the Ministry of Finance, which is yet to give formal approval to the proposed regulations. Tax free status: GOB has allowed the growth of the NGO-MFIs without either trying to contain that growth or seeking to collect tax from their operations. The tax free status has helped to build larger equity base that made them more stable and allowed them to borrow from commercial banks. Interest Rate: Government of Bangladesh (GOB) did not decide or interfere in interest rates charged by the MFIs on their loan and paid on the savings products. Historically the rates were set by the large MFIs and followed by smaller MFIs as the going rate(s). However, there has been one exception where PKSF asked its partner organizations to reduce interest on loans from 15% (Flat) to 12.5% (flat) beginning July 2004 because it provides subsidized capital to the partner MFIs. Even with this rate its partners are found to be financially viable. 11

12 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation Legal Status of RDS: Since RDS is part of IBBL comes under the supervision of the Bangladesh Bank not under MRA and does not require license from MRA. Impact of Microfinance There have been many impact studies conducted on microcredit programs beginning mid- 1980s through 1990s. The pioneering impact study on the microcredit program of the Grameen Bank was by Mahbub Hossain [Hossain 1988] who evaluated it using the indicators like reaching the target groups, size of loan disbursed, loan utilization, accumulation of capital, generation of employment, and income, and poverty status, and used before and after as well as comparison between borrowers and non-borrower control groups to see the impact of microcredit. This was conducted in a backdrop of skepticism about the success of Grameen Bank and whether the poor borrowers really invest the loan and actually earn enough to repay the loan as well as enhance family income. Methodologically this study was probably the most robust that used statistically valid sample as well as had an opportunity to compare with control group at a time when microcredit was not so widely available. The data were collected through field surveys in 1985 conducted in five selected project and two control villages in the area of operation of 5 branches of the Grameen Bank. The sample size consisted of 975 borrowers and census of all households in seven villages. An earlier study was done in 1984 [Hossain, Mahbub 1984]. The study [Hossain 1988] reported a number of concrete contributions of microcredit from the bank: Borrowers have increased their business capital by an average three times within a period of 27 months; Asset in the form of livestock increased by 26% per year; About one third of members who reported to be unemployed became selfemployed after joining microcredit program of the bank; Grameen Bank members had incomes about 43% higher than target groups in control villages, and 28% higher the target group non-participants in the project villages. The enhanced income is from the income generating activities undertaken by using microcredit. The program is general enhanced overall income of households in the project villages: average household income is about one-sixth higher in project villages than in the control villages. Thus microcredit has reduced poverty. Bangladesh Institute of Development Studies (BIDS) carried out a major comparative study of poverty alleviation programs in Bangladesh that included 10 programs of eight (8) organizations-both government and non-government [BIDS 1990]. The investigations were carried out in 30 villages covering nearly 6000 households that included household census and intensive sample surveys. The difference in this study is that it compared the same indicators for all programs to determine relative success or failure. As a part of the above analysis, comparative study was done to compare the credit programs of BRDB- RPP, BRAC-RDP and TRDEP [Bhattacharya 1990]. It reported success of all three 12

13 8 th International Conference on Islamic Economics and Finance programs in reaching the poor (a percent of non-target people was also found joining the microcredit groups), enhancing income and creating self-employment due to microcredit. A number of important studies have been conducted on the programs of the Palli karma- Sahayak Foundation and its partner organizations (microfinance institutions that receive loan from PKSF to on lend to poor). We will discuss two studies Rahman (1996) and BIDS [2001]. Although the methodologies applied in these two studies are somewhat similar to other impact studies but the importance of the two studies is that both measured impact of microcredit from smaller microcredit institutions, which follow Grameen Bank model, to show that impacts of income and other indicators are similar. This shows robustness of the microcredit system that has been successfully replicated to reach millions of poor left outside the Grameen Bank or a few large organizations. The smaller MFIs replicated the management system and showed that if poor were reached with financial services they could use them efficiently irrespective of sources. Rahman [1996] analyzed the impacts of microcredit using cross-sectional comparison of households who had borrowed and those had not. A stratified random sampling method was followed for selection of MFIs of different size: small, with less than 2000, medium with members between 2000 and 3000 and large with members above Eight (8) partner MFIs were randomly selected by allocating proportion to the number of partner MFIs in each three categories. For each selected partner MFIs, 40 households were randomly selected from the list of 3 types of members: the non-borrowers, those who borrowed only once and those who borrowed for more than once. Forty (40) households were selected to give a reasonable size of sample in each stratum and the total sample was 960. A survey was used among the selected households using a structured questionnaire. It was a preliminary study only after two years of PKSF s operations. The major findings of the study are as follows: Microcredit enhanced household income. Though the income increase was modest, this reduced food insecurity, and increased expenditure on clothing and human capital development. Income and awareness increase due to membership in MFIs led to better children s school attendance and immunization. Microcredit increased employment of both men and women in the form of selfemployment; women participation in IGAs had increased. Women were found very active and enterprising when provided with opportunities for investment. On the other hand, the study by Zahir et al [BIDS 2001] is more detailed and used panel data. The study area included 13 regions of Bangladesh, covering 91 villages spread over 23 sub-districts. Following a census of all households in the 91 villages during October 1997, the study administered three repeat surveys, on a matched sample of about 3000 rural households during 1998, 1999 and Besides collecting information at household levels, separate modules were administered on MFI-members from these households and for village and samity-level information. Major findings are as follows: 13

14 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation Microcredit from smaller MFIs supported numerous income-generating activities, mostly of self-employment nature. A proportion of microcredit recipients owned cattle, and control land ownership; the participants earned higher income from livestock than non-participants. Self-employment accounts for a higher share of (regular) program participants annual income, compared to others. However, petty trading activities dominate, accounting for almost half the income earned from self-employment activities. While the direct and indirect impacts of microfinance have all led to increases in rural self-employment activities, it is primarily in the area of transport services where the programs have made significant contribution. Estimates on household income showed that self-employment activities were most severely affected by the flood. As a consequence, real income of poor households declined during the flood year, even though the average income of all sample households had increased. Participation in programs and access to credit had however helped in containing the negative effects of flood. Multivariate analysis in the study shows that there is significant positive effect of regular program participation on income and on average consumption of poor households. Particularly, increases in the consumption of pulse, fish and milk are more prominent among MFI borrowers, when controlled for land ownership. Both head-count and poverty gap measures show that regular participation registered a faster rate of poverty reduction than occasional participants, and reduction in poverty among the latter was faster compared to non-participants. A comparison across the first ( ) and the third ( ) round shows the larger percentage of program participants tend to invest on both human and physical capital. Participation in MFI programs is found to have led to decline in gender gap in access to schooling and to modern health care. Generally, the study finds program participants to be less vulnerable to crises even though they face similar degree of crises as non-participants. A summary of major quantitative impact studies has been presented by Rahman [2000] as reproduced below: 14

15 8 th International Conference on Islamic Economics and Finance Source Table 4: Impact of microcredit on household income/expenditure Name of organization studied Income or expenditure per annum (Taka) Participants Control (nonparticipants) Hossain 1984 GB Income, per capita Hossain 1988 GB Income, per capita BIDS 1990 BRDB Income, per household BIDS 1990 BRAC-RDP Income, per household IMEC 1995 Proshika Income, per household 22,244 17, Rahman 1996 PKSF Expenditure, per household % change 26,390 23,802 10,9 Khandakar 1998 BRAC Expenditure, per capita Khandakar 1998 GB Expenditure, per capita Khandakar 1998 RD-12 Expenditure, per capita Halder 1998 BRAC Expenditure, per capita BIDS 1999 PKSF Expenditure, per capita 36,528 33, IMEC 1999 Proshika Income per household 48,635 43, Source: Rahman [2000] The sector has observed gradual loss of interest for rigorous quantitative analysis for several reasons: high expenses; need for experienced expert human resources to conduct such studies; and on many occasions researchers reported difficulty of finding control groups due to massive expansion of microfinance programs to make any meaningful conclusion about the impact of any particular program. Methodological innovations have been made to isolate impacts of overall microfinance program even if a particular borrower receives loans from many different sources. At the same time, researchers face challenges to isolate social and economic impacts of microcredit because such impacts are and can be derived from many different sources. This has led to application of qualitative approaches of impact study emphasizing the views of the members/borrowers to determine impact of microfinance. This type of approach starts with the notion that the members/borrowers are in the best position to say whether they have benefited from the program. This approach is cost-effective, which also tries to bring out the various qualitative and social aspects of impact of microfinance as well as other development interventions. 15

16 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation Commercial banks 3. Commercial Banks in Retail Microcredit The formal banking sector comprises four categories of organizations: the state-owned banks (nationalized commercial banks (NCBs)) namely Sonali, Agrani, Janata, and Rupali Banks; six specialized; private banks; and foreign (commercial) banks. Following the success of Grameen Bank the four NCBs and two agricultural banks started to offer retail microcredit by replicating group-based management technology, in addition to their individual small loans for agricultural as well as other purposes. Invariably all such group-based programs managed directly by the bank staff members have collapsed with huge default of loans. Currently NCBs have largely abandoned lending to group-based small loan programs but have maintained their original individual loan operations. Commercial banks, state-owned and private, are offering wholesale loans to MFIs at interest rates varying between 10-15%. The exception is IBBL, which has large retail microfinance operations as described below in this paper. RDS-IBBL Islami Bank Bangladesh Limited was founded with the major objective of establishing Islamic economy for balanced economic growth by ensuring reduction of rural-urban disparity and equitable distribution of income. Islami Bank Bangladesh Limited (IBBL), the largest private bank in the country is the only commercial bank that offers Grameen styled retail microcredit to a large number of borrowers. The microcredit program known as Rural Development Scheme was launched in 1995 as pilot program styled after the Grameen Bank model except that the scheme used Islamic modes of investment. The program runs side by side with the commercial banking operation of the bank and forms groups of women to provide small loans. RDS caters to the investment needs of the agriculture and rural sector to create opportunity for generation of employment and raising income of the rural people with a view to alleviate poverty. Branches of the Bank are encouraged to invest their deposits in their respective areas and in particular for the economic uplift of the rural people. Objectives: The main objectives of RDS are: To extend investment facilities to agricultural, other farming and off-farming activities in the rural areas. To finance self-employment and income generating activities of the rural people, particularly the rural unemployed youths and the rural poor. To alleviate rural poverty through integrated rural development approach. To extend investment facilities for hand tube-wells and rural housing, keeping in view the needs of safe drinking water and housing facilities of the rural dwellers. To provide education and Medicare facilities to the down-trodden people. 16

17 8 th International Conference on Islamic Economics and Finance Area Selection: Initially RDS started as a pilot operation in the rural areas of several districts under the direct supervision of the nearby Branches of the Bank. At present, it is extended to all the 61 districts out of 64 districts of the country through 139 Branches of the Bank. The metropolitan areas and three Chittagong Hill Districts are kept outside of RDS. Command Area and Baseline Survey: Each designated Branch selects villages within a radius of 16 km of the Branch. Following criteria are followed to select a village: Ease communication so that staff members can easily attend weekly meetings; Availability of agriculture and other off-farm activities; and Abundance of low-income people; After primary selection of an area consisting of 4 to 6 villages, the Branch conducts detailed baseline survey to identify the target group people (clients/customers) and varieties of business opportunities in the area. The Branch has to ensure the availability of at least 400 target group people in the selected area. Present operations: The present size of RDS is presented in the following Table 5. Table 5: IBBL RDS (Microcredit) Description # of branches offer RDS Villages 4,560 8,057 10,023 10,676 10,751 Members/clients 217, , , , ,475 Investment Outstanding (Taka million) 1, , Source: RDS/IBBL , Comparison of Financial Services: RDS versus MFIs This section is devoted to present RDS is details in comparison with a typical MFI. In this connection we will mention various policies of RDS, Grameen Bank, ASA, BRAC and BURO Bangladesh, as appropriate to compare and contrast various issues. We follow a similar methodology of Hassan and Dewan (2002) to do this comparative analysis of Islamic and conventional microfinance institutions. Target market or client groups We mentioned that MFIs broadly offer financial services to four different segments: hardcore poor, moderately poor (mainstream microcredit), microenterprise and marginal and small farmers. However, not all MFIs offer services to all four segments. RDS 17

18 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation basically offer services to all four segments, although the bulk of the investments is for moderately poor families. RDS defines its target population as follows: Physically fit and industrious rural poor within age group of and permanently reside in command are of the branch; Farmers having cultivable land maximum 0.50 acres and or sharecroppers; Persons engaged in very small off-farm activities in the rural areas; Destitute women; but Persons with loan outstanding with other banks/institutions are not eligible for investment under RDS. The target groups are similar to any other MFIs in the country and expected to be the same because MFIs and RDS-IBBL operates in the same geographical areas. In 2003 RDS introduced loan for microenterprises to offer larger loans to graduated clients. Group management RDS has literally replicated basic Grameen Bank s group management system as its basic field structure as follows: Small Groups to be formed consisting of 5 members preferably of similar professions/ occupations. The members of the Group select their Group Leader and Deputy Group Leader to co-ordinate the Group activities. After formation of the Group, the Branch Manager visits the Group and has discussion with the Group members and then he gives formal recognition of the Group through issuance of Pass Books. A Centre is formed by minimum 2 to maximum 8 Groups. The group leaders under a particular centre select the Centre Leader and Deputy Centre Leader from amongst themselves to co-ordinate the Centre activities. The Centre has to conduct regular weekly meeting. The weekly meetings are to be organized in a particular place, day and time as decided in the meeting of the Centre. Centre meetings are recorded in a Resolution Book along with signature of the members (members who do not know signature must learn it). Attendance in the Centre meeting is the first requirement to become a dependable client member of the Scheme. The Centre meetings are conducted by the Field Officers with the following agendas: (a) Discussion on different Islamic topics, moral values, social rights & responsibilities, (b) Collection of Investment Installments, Personal Savings, Centre Fund etc., (c) Appraisal & approval of Investment proposals, etc. Investment client are selected in the Centre meeting and supplied with the application forms and other related papers. On finalization of the investment application, the list of the selected clients, supported by their applications, are 18